Business context and reporting period
The Charles Schwab Corporation filed this Form 10-K for the fiscal year ended December 31, 2016. Schwab provides wealth management, brokerage, banking, asset management, custody, and advisory services through Investor Services and Advisor Services. The fourth-quarter figures below are unaudited; the annual financial statements were audited.
At year-end, Schwab reported $2.78 trillion in client assets, 10.2 million active brokerage accounts, and approximately 16,200 full-time-equivalent employees. Management emphasized client growth, advice offerings, scale, and expense discipline.
Financial and operating performance
| Metric | 2016 | 2015 |
|---|---|---|
| Net revenues | $7.478 billion | $6.380 billion |
| Net income | $1.889 billion | $1.447 billion |
| Net income available to common stockholders | $1.746 billion | $1.364 billion |
| Diluted EPS | $1.31 | $1.03 |
| Expenses excluding interest | $4.485 billion | $4.101 billion |
| Pre-tax profit margin | 40.0% | 35.7% |
| Net cash provided by operating activities | $2.662 billion | $1.246 billion |
- Net interest revenue rose 32% to $3.322 billion; average net interest margin increased 13 basis points to 1.73%.
- Asset management and administration fees rose 15% to $3.055 billion. Trading revenue declined 5% to $825 million, primarily reflecting lower average revenue per trade.
- Average interest-earning assets increased 21%. Schwab attributed growth to client asset gathering, transfers of sweep cash to Schwab Bank, and making Schwab Bank the default sweep option for virtually all new brokerage accounts from June 2016.
- Net revenue grew 17%, while expenses excluding interest grew 9%. Compensation and benefits increased 10% to $2.466 billion, partly reflecting headcount and business growth.
- Fourth-quarter 2016 net revenues were $1.972 billion, net income was $522 million, net income available to common stockholders was $478 million, and diluted EPS was $0.36.
- Investor Services reported $2.031 billion of pre-tax income, up 21%; Advisor Services reported $962 million, up 61%. Advisor Services revenue grew 28%, including strong net interest revenue growth.
Balance sheet, capital, and liquidity
- Total assets increased 22% to $223.383 billion. Bank deposits rose to $163.454 billion from $129.502 billion, including $141.146 billion swept from brokerage accounts.
- Long-term debt was $2.876 billion, essentially unchanged from 2015. Total stockholders’ equity increased to $16.421 billion, including $2.783 billion of preferred stock. The debt-to-total-capital ratio was 15%.
- Cash and cash equivalents were $10.828 billion at year-end, down $1.150 billion. Cash flows included $38.775 billion used in investing activities, primarily reflecting investment-security purchases, and $34.963 billion provided by financing activities, largely from higher bank deposits.
- CSC’s Tier 1 leverage ratio was 7.2%; Schwab Bank’s was 7.0%. Schwab Bank met the regulatory definition of well capitalized. The company reported compliance with the fully phased-in modified Liquidity Coverage Ratio requirement at year-end, but did not provide a clear LCR percentage in the supplied text.
- Schwab had $750 million available under its committed unsecured credit facility, scheduled to expire in June 2017; it was unused at year-end. Schwab Bank also had $16.5 billion available under its Federal Home Loan Bank facility and $849 million available through the Federal Reserve discount window.
Material changes, outlook, and risks
- Client assets increased 11% to $2.780 trillion, while core net new client assets were $125.5 billion, down from $134.7 billion in 2015. Assets receiving ongoing advisory services increased 12% to $1.401 trillion.
- Management said higher short-term rates supported net interest revenue and money-market fund fee yields. Its balance-sheet positioning was designed to benefit from rising rates, while its simulation estimated a 6.5% increase in next-12-month net interest revenue under a gradual 100-basis-point rate increase and a 9.8% decrease under a 100-basis-point decline. These are modeled sensitivities, not guidance.
- The filing provides no specific earnings or revenue guidance. Management identified market levels, interest rates, client asset flows, pricing competition, regulation, and expense management as important drivers of future results.
- Key risks include interest-rate and market sensitivity; deposit and liquidity outflows; regulatory capital and liquidity requirements; cybersecurity, technology, and vendor disruptions; credit exposures from lending and securities; pricing competition; and litigation or regulatory actions. The company had $223.4 billion in assets, below the $250 billion threshold that would trigger Basel III advanced-approaches requirements described in the filing.
- Mortgage and home-equity exposures include geographic concentration: 48% of the combined First Mortgage and HELOC portfolio was in California. The company also held $1.2 billion of FFELP asset-backed securities rated below investment grade by two agencies, while management cited government guarantees and additional credit enhancement.
- Other revenue included $16 million of litigation proceeds in 2016 related to the non-agency residential mortgage-backed securities portfolio, compared with $75 million in 2015. This reduced the prior-year contribution from that item.
- The Total Bond Market Fund litigation remained on appeal, and the company said it could not reasonably estimate potential liability in significant pending matters. An SEC proceeding against optionsXpress concluded in 2016 with fraud charges dismissed and financial sanctions affirmed; the company described the sanctions as not material.
- The common dividend was increased to $0.07 quarterly in 2016; in January 2017 the board declared a further increase to $0.08. There were no company-program share repurchases in 2016, and $596 million remained authorized. Management announced that Peter Crawford would become CFO effective May 16, 2017.
Most important facts for investors to verify
- Whether continued growth in deposits, client assets, and advice-related assets can sustain net interest revenue and fee growth.
- The sensitivity of earnings to further rate changes, including deposit pricing, sweep-cash migration, and the rate of repricing on assets and liabilities.
- The quality and concentration of the investment and loan portfolios, particularly mortgage-related holdings, California housing exposure, and HELOC repayment transitions.
- Progress on regulatory requirements, including liquidity compliance, capital buffers, and the implications of asset growth toward the $250 billion threshold.
- Developments in pending litigation and regulatory matters, for which potential losses may not yet be reasonably estimable.
- Whether expense growth, including investment in employees and technology, remains below revenue growth as the business expands.
Deloitte & Touche LLP issued an unqualified audit opinion on the financial statements and internal control over financial reporting; management also concluded that disclosure controls were effective at December 31, 2016.